What is Intrinsic Stock Value

655 views

Published on

By www.ProfitableInvestingTips.com


What is Intrinsic Stock Value?

In the aftermath of the stock market crash of 1929 in the early days of the Great Depression Benjamin Graham introduced the concept of value investing. No longer would those buying and selling stocks need to act like they were at the casino. With the concepts of intrinsic value and margin of safety Graham taught investors a rational means of investing in stocks. With this in mind just what is intrinsic stock value? And how does this concept help with profitable stock investing?

What Is Intrinsic Stock Value?

The dictionary definition of intrinsic stock value is its fundamental value. It is obtained by adding up predicted future income of a stock and subtracting current price. It can also be seen as actual value of an equity versus its book value or market value. The concept of fundamental analysis of equities evolved from this concept. Using fundamental analysis the intrinsic value of a stock is the expected company cash flow discounted to current dollars. It is a discounted cash flow valuation. An inherent weakness in this concept is that too often the medium and long term prospects of a company and its stock price are not clear. So, what is intrinsic stock value of a company if the future is uncertain? The ability to see into the future to see how well a company will manage its assets, products, costs, R&D, and marketing is of utmost importance in calculating intrinsic stock value as a means of deciding whether or not to purchase a stock.
What is Intrinsic Stock Value as a Formula?

Mr. Graham presented investors with a formula for calculating intrinsic stock value in 1962 and modified it in 1974. The 1974 version considers the following:
• Earnings per share, EPS, for the preceding twelve months
• A constant of 8.5 representing an expected price to earnings ratio, P/E ratio, for a company that is not growing
• An estimate of long term growth, five years = g
• A constant of 4.4 which was the average yield of high grade corporate bonds in the early 1960 decade
• The current yield of AAA corporate bonds = Y
• Where V = intrinsic value

The formula is as follows:
V = (EPS x (8.5 + 2g) x 4.4)/Y

The way the investors were encouraged to use intrinsic value was to derive what is referred to as a Relative Graham Value, RGV. This is to divide the calculated intrinsic value of the stock by its current price. If the result, the RGV, is less than one the stock is overvalued and a bad investment and if the ratio is above one it is undervalued and may be a good investment.

What is Intrinsic Stock Value as an Investing Tool?

There are a couple of difficulties in using the simple calculation above to determine the forward looking earnings of a stock and therefore its intrinsic value. First of all the formula does not account for inflation. Thus one could use the formula and end up with a stock valued higher in dollars but in dollars that are inflated.

Published in: Business, Economy & Finance
0 Comments
2 Likes
Statistics
Notes
  • Be the first to comment

No Downloads
Views
Total views
655
On SlideShare
0
From Embeds
0
Number of Embeds
2
Actions
Shares
0
Downloads
48
Comments
0
Likes
2
Embeds 0
No embeds

No notes for slide

What is Intrinsic Stock Value

  1. 1. In the aftermath of the stock market crash of 1929 in the early days of the Great Depression Benjamin Graham introduced the concept of value investing.By www.ProfitableInvestingTips.com
  2. 2. No longer would those buying andselling stocks need to act like they were at the casino.By www.ProfitableInvestingTips.com
  3. 3. With the concepts of intrinsic value and margin of safety Graham taught investors a rational means of investing in stocks.By www.ProfitableInvestingTips.com
  4. 4. With this in mind just what is intrinsic stock value?By www.ProfitableInvestingTips.com
  5. 5. And how does this concept help with profitable stock investing?By www.ProfitableInvestingTips.com
  6. 6. By www.ProfitableInvestingTips.com
  7. 7. The dictionary definition of intrinsic stock value is its fundamental value.By www.ProfitableInvestingTips.com
  8. 8. It is obtained by adding up predicted future income of a stock and subtracting current price.By www.ProfitableInvestingTips.com
  9. 9. It can also be seen as actual value of an equity versus its book value or market value.By www.ProfitableInvestingTips.com
  10. 10. The concept of fundamental analysis of equities evolved from this concept.By www.ProfitableInvestingTips.com
  11. 11. Using fundamental analysis the intrinsic value of a stock is the expected company cash flow discounted to current dollars.By www.ProfitableInvestingTips.com
  12. 12. It is a discounted cash flow valuation.By www.ProfitableInvestingTips.com
  13. 13. An inherent weakness in this concept is that too often the medium and long term prospects of a company and its stock price are not clear.By www.ProfitableInvestingTips.com
  14. 14. So, what is intrinsic stock value of a company if the future is uncertain?By www.ProfitableInvestingTips.com
  15. 15. The ability to see into the future to see how well a company will manage its assets, products, costs, R&D, and marketing is of utmost importance in calculating intrinsic stock value as a means of deciding whether or not to purchase a stock.By www.ProfitableInvestingTips.com
  16. 16. By www.ProfitableInvestingTips.com
  17. 17. Mr. Graham presented investors with a formula for calculating intrinsic stock value in 1962 and modified it in 1974. The 1974 version considers the following:By www.ProfitableInvestingTips.com
  18. 18. Earnings per share, EPS, for the precedingtwelve months.A constant of 8.5 representing an expectedprice to earnings ratio, P/E ratio, for a companythat is not growing.A constant of 4.4 which was the average yieldof high grade corporate bonds in the early 1960decade.The current yield of AAA corporate bonds = Y.Where V = intrinsic value.By www.ProfitableInvestingTips.com
  19. 19. The formula is as follows: V = (EPS x (8.5 + 2g) x 4.4)/YBy www.ProfitableInvestingTips.com
  20. 20. The way the investors were encouraged to use intrinsic value was to derive what is referred to as a Relative Graham Value, RGV.By www.ProfitableInvestingTips.com
  21. 21. This is to divide the calculated intrinsic value of the stock by its current price.By www.ProfitableInvestingTips.com
  22. 22. If the result, the RGV, is less than one the stock is overvalued and a bad investment and if the ratio is above one it is undervalued and may be a good investment.By www.ProfitableInvestingTips.com
  23. 23. By www.ProfitableInvestingTips.com
  24. 24. There are a couple of difficulties in using the simple calculation above to determine the forward looking earnings of a stock and therefore its intrinsic value.By www.ProfitableInvestingTips.com
  25. 25. First of all the formula does not account for inflation.By www.ProfitableInvestingTips.com
  26. 26. Thus one could use the formula and end up with a stock valued higher in dollars but in dollars that are inflated.By www.ProfitableInvestingTips.com
  27. 27. The second problem is more to the point. How does one see the future of a stock? Stocks and stock markets rise and fall.By www.ProfitableInvestingTips.com
  28. 28. Thus investors astute at finding themargin of safety of a stock protect themselves against market fluctuations that can damage investments based on a simplecalculation of intrinsic stock value.By www.ProfitableInvestingTips.com
  29. 29. For more insights and usefulinformation regarding investments and investing, visitwww.ProfitableInvestingTips.com.

×